The founder of India's Sun Pharmaceutical Industries Inc, Dilip Shanghvi, has agreed to buy a 23 percent stake in Indian wind turbine maker Suzlon Energy Ltd for about $290 million, the company said late on Friday.

Suzlon to turnaround
Sun Pharma is India’s largest pharma company by value and one of the largest generic companies in the world. The company has grown at a rapid pace in the last few years and has been the poster child of India’s pharma...

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Suzlon Energy Limited (BSE: Suzlon) is a wind energy company based in India that manufactures wind turbine power generators and services wind park systems. Suzlon's aggressive expansion strategy focuses on low-cost production and regional price discrimination. As the world’s third largest wind-turbine manufacturer with a market share of 9.8% globally and 50% in India,[1] Suzlon expanded rapidly before the financial downturn of 2008, acquiring suppliers to vertically integrate along its supply chain. However, Suzlon has since divested some of these investments.

Suzlon customers in both the United States and India have reported that Suzlon's wind turbines cracked in high winds and failed to deliver the power outputs stated in sales contracts. Other quality control issues led some customers to cancel orders from Suzlon and to purchase wind turbines from other suppliers. The company repaired 1,251 turbine blades for a total of $100 million in warranty costs.[2] Not only are faulty turbine blades expensive to repair, but they damage the company's image.

Wind power is a fully renewable source, and it produces little pollution, making it one of the cleanest sources of power. Though advances in technology are making wind energy more economically feasible, oil prices have made renewable energy sources less financially attractive. However, since fossil fuels are a non-renewable source of energy, alternative energy sources (wind, geothermal, solar) have the potential to become significant sources of energy, and Suzlon is poised to benefit as the third largest wind turbine manufacturer in the world.

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Suzlon signed its first South African deal for supplying turbines and is in talks with four more South African Clients. Suzlon is also eying at South Africa as a possible manufacturing base to join the ones it already has in India, China, Germany and Brazil. The deal is with African Clean Energy Developments (ACED) for a proposed wind farm in the rural town of Cookhouse in Eastern Cape Province.[3]

Company Overview

Suzlon, based in India, specializes in the low-cost manufacture of wind energy solutions that convert the kinetic energy in wind to electricity. Its customers include governments and corporations such as utility companies. The company produces turbines and generators at its production facilities in India, China, Belgium, and the United States and offers comprehensive wind power packages, including servicing for all its products.[4]

Business Segments

Suzlon produces two major lines of turbines: the Megawatt series and the Multi-Megawatt series, which can generate energy in capacities from 350 kilowatts to 2.1 megawatts.[5] Watts are a measure of power, and the main differences between the two series is the power-generating capacity.[6] Suzlon's wind parks are multi-turbine parks that allow the company to increase profit margins through economies of scale. In addition, once turbines are produced and installed, Suzlon maintains a low level of revenue by servicing wind turbines.

Acquisitions and Divestitures

Before the financial downturn in 2008, Suzlon aggressively pursued an acquisition strategy to absorb smaller competitors and to vertically integrate along its supply chain. For example, in 2007 Suzlon acquired the German wind turbine manufacturer REpower for $1.7 billion (USD) in order to reduce competition and to acquire new product lines. REpower controls 10% of German market share and gives Suzlon a strong foothold in the Western European market.[7]

However, a weakened U.S. wind turbine market has made Suzlon managers reconsider its expansion strategy. Suzlon sold a 35% stake in a subsidiary, Hansen Transmissions, for $370 million, as part of its efforts to reduce debt.[8] After selling Hansen, Suzlon's stake in the gearbox maker declined to 26% from 61%.[8] This is the second divestment of Suzlon's stake in Hansen in 2009, with the firm selling 10% in January to the London-based investment firm Ecofin.[8] Suzlon bought the Belgium-based Hansen in 2006 for $565 million.[8]

Suzlon remains saddled with debt from its rapid expansion strategy. Suzlon took on major debt in 2007 to acquire REpower for $1.7 billion and to build new factories in the U.S., China, and India.[9] Credit Rating Information Services of India estimated that the $2.2 billion of net debt Suzlon reported for the end of 2008 was 1.5 times its equity at that time.[9]

Trends and Forces

Suzlon is focusing on globalizing through a number of methods. First, it benefits from India's depreciating currency, the rupee, as its products are seen as cheaper by the rest of the world. Second, Suzlon offers varying packages in different places depending on price levels; in China, where prices are low, Suzlon offers full power plants, but in the U.S., Suzlon installs cheaper turbine generators. This price discrimination allows Suzlon to cut costs while maximizing its profit margin. Finally, Suzlon is increasing its global reach with its R&D branch in Europe, production in India and China, and a sales focus in the top global wind markets. In 2005, 90% of Suzlon’s sales were in India; by 2008, international sales accounted for 60% of the total.[2]

Suzlon continues to expand its operations to new countries as well as strengthen its position in existing markets. For example, in 2010, Suzlon received its first order in Sweden from Triventus AB, a Swedish wind power developer. The company ordered two 2.1 MW wind turbines.[10] Additionally, as of November 2010, Suzlon plans to set up offices in several Latin American countries, including Mexico, Argentina, and Chile.[11]

Though most of Suzlon's business comes from the United States, Europe is a larger and faster growing wind market. This is an important consideration for Suzlon, which is expanding its coverage of European markets.

Though Suzlon is expanding internationally, it is still focusing on growing in India. For example, in 2011, Suzlon announced an order for 1,000 MW of wind turbines worth $1.28 billion (Rs 5,800 crore) from Caparo Energy India. This contract and other large orders such as one from Vedanta will give significant visibility to Suzlon in the Indian market.[13]

Low Speed Wind Turbines Could Broaden the Appeal of Wind Energy

Suzlon is investing in low speed wind turbines and is hoping to gain an early mover advantage in this segment of the wind turbine market. The company is planning to release its prototype of the class-III turbine. The turbine, which no company manufactures yet, is expected to reach the market by August 2011.[14]

Wind turbine manufacturers, including Suzlon, currently produce class-I and class-II turbines. Class-I turbines are designed for wind speeds of more than 8.5 meters per second (m/s). Class-II turbines are designed for wind speeds of 7.5-8.5 m/s, class-III for 4.5-7.5 m/s, and class-IV for less than 4.5 m/s.

Class-IV turbines are not economically viable now, given that 99% of the wind farms globally come up in class-II areas. Suzlon currently manufactures wind turbines having a blade diameter of 88 meters. The new class-III wind turbine has a blade diameter of 97 meters.

Suzlon spends Rs400-500 crore, or about 2% of its revenues, annually on research and development of new turbines. Suzlon’s competitors, GE Energy and Vestas (VWSYF), are also working on class III turbines.

Problems with Suzlon's Turbines Threaten Long-Term Viability

Suzlon's turbines have gained a reputation for being faulty. U.S. customers complained of cracking turbine blades, and the company came under fire from Indian customers for supplying turbines having control issues, shaking in the wind, and producing less energy than guaranteed by sales contracts, causing utility companies to incur large costs.[15] In April 2009, Suzlon signed a contract to supply blades for 75 turbines in a project being managed by REpower in China's Shandong province. REpower rejected the turbine prototype provided by Suzlon and ordered the equipment from another supplier.[16] And though Suzlon promises its customers that turbines will be available to produce power at least 95% of the time the wind is blowing with limited downtime for maintenance, often its products have had significantly lower availability rates.[2]

More recently, the blades of a Suzlon S88 generator in Rugby, North Dakota, fell from their mount. This caused the wind generation plant to suspend its operations while the operator investigates the cause. This is the same model that suffered cracked blades, prompting Suzlon to strengthen the components at a cost of $25 million.[17]

Faulty turbine blades and quality control issues lead to lost revenue, and contracts that Suzlon loses due to faulty equipment are awarded to its competitors. Additionally, Suzlon incurs significant costs in repairing faulty turbine blades. Suzlon has only two wind turbines in the United States left to retrofit with new blades after replacing the blades on all of its nearly 400 turbines in the country.[18] The company undertook the retrofit program after cracking caused one blade to break off a turbine in Illinois in 2008.[18] Suzlon reported in 2008 that it has spent $30 million (Rs129 crore) to fix faulty wind turbines.[2] Not only are faulty turbine blades expensive to repair, but they also damage Suzlon's company image.

Electrical Generation by Source for 2008[19] Excluding hydropower, less than 3 percent of the U.S. power generation comes from renewables such as wind and solar

The global market for wind turbine installations in 2008 was worth about $47.5 billion, an increase of approximately 42 percent over 2007.[20] Growth in global wind capacity in 2008 exceeded the average growth rate for the past 10 years. Global wind capacity increased 27,051 megawatts in 2008, ending the year at 120,798 megawatts.[20] This represented a growth of 29% in 2008 with the U.S. overtaking Germany as the world's leading wind power generator.[20]

U.S. wind capacity increased by 50 percent in 2008 to 25,170 megawatts.[20] As of 2008, Suzlon had 1,910 MW of wind capacity installed in the U.S., accounting for 55% of its global installations.[4] For the first time, wind power represented Europe's leading source of new electric capacity with 8,877 megawatts added, compared to 6,939 megawatts of natural gas capacity added and 763 megawatts of coal capacity added.[20] By the end of 2008, wind power accounted for 8 percent of the European Union's power capacity, enough to generate 4.2 percent of the region's annual power needs.[20] At the end of 2008, the European Union accounted for 267 MW of Suzlon's total installed capacity, or 8%.[4] Asia accounted for almost one-third of global wind capacity additions in 2008.[20] China ranked second after the United States, with approximately 6,300 megawatts installed during the year.[20] This doubled its cumulative wind capacity for the fourth year in a row.[20] Suzlon had 586 MW (17% of total global capacity) installed in China and 160 MW (5%) in India. Suzlon has benefited from the increase in demand for wind energy in 2008, especially given its strong presence throughout the world. Suzlon has recently become more globally diversified; in 2005, 90% of Suzlon’s sales were in India; by 2008, international sales accounted for 60% of the total.[2] Suzlon’s presentations to investors predict exports will jump to 75% of total sales in 2009, with the U.S., China and Europe accounting for an equal share.[2]

Demand for renewable energy is growing in emerging markets

Since demand for wind turbines has fallen sharply in the U.S. and European markets, Suzlon has focused on increasing sales in India, Brazil and China. At the end of the quarter ending June 2010, Suzlon’s order backlog improved to 1,459 Mw, compared to 1,126 MW in the March quarter.[21] This was led by India’s order backlog touching an all-time high of 580 MW. The company is also increasing its capacity in Brazil, where it commands over half of the market share and expects more projects in the near term.[21]

Although the demand from the Indian and other emerging markets is growing, the outlook for large markets like the U.S. and Europe will continue to weigh on Suzlon's results [21]

Despite the rapid growth in the wind energy sector in 2008, the turbulent economic environment and global credit crunch have led some of the fast growing markets like the U.S. and Europe to slow in terms of new capacity additions. For example, Emerging Energy Research estimates that new wind plant activations in Europe in 2009 could drop by as much as 18% compared to 2008.[22] Europe is expected to add 7,836 megawatts of wind power capacity in 2009, down from 9,556 in megawatt additions in 2008.[22] The credit crunch has also reduced the number of wind projects that are able to close financing, leading to installation postponements in the United Kingdom, Italy, and France.[22]

According to the Danish consulting firm MAKE, wind turbine manufacturers reported a 50% drop in orders in the first half of 2009.[23] In response to falling demand, Suzlon cut 90 of the 300 workers it had employed at its Minnesota plant in 2009, which has the capacity to build 300 turbines per year.[18] However, analysts expect demand to increase in the fourth quarter. Suzlon expects to sell equipment capable of generating 2,600 MW of electricity in the year ending March 31, 2010, down from 2,790 MW installed a year earlier.[23] The projected drop in Suzlon’s sales volume will be its first in at least six years; the company’s sales volume has increased every year since the period ended March 2004.[23]

Pollution Control

Oil and coal combustion release carbon dioxide and monoxide, as well as nitrogen oxides, sulfur oxides, ozone, and other pollutants that contribute to acid rain, smog pollution, as well as asthma and respiratory problems in the general populace. Increasing awareness of these issues has led to movements to push for government regulation of pollution, and higher energy prices have driven development of clean coal technologies. However, coal and oil can only be burned cleanly up to a certain point and, as a result, there is growing support for government investment in clean energy sources such as wind power. Suzlon is poised to benefit from this trend as it is already an established producer of wind power technology.

Falling Oil and Gas Prices Limit Demand for Renewable Energy

Fossil fuels and coal are not renewable because there is a limited quantity of both resources on the earth, and the replenishment of these resources takes hundreds of thousands of years. As oil becomes more rare, prices increase and new energy sources become increasingly feasible from a financial perspective.

Oil and gas prices have fluctuated heavily over the past few years, but the most recent trend has been a significant decline in prices. The price of crude oil fell from a record high of nearly $150 a barrel in July 2008 to around $50 a barrel in the first quarter of 2009.[24] As falling oil and gas prices lead to more affordable commercial electricity, consumers limit their demand for new, often expensive sources of renewable power.

Suzlon would benefit from decreases in the production cost of wind turbines as technology improves and production processes become more efficient.

Objections to Wind Power

The main objections to wind power stem from environmental costs. Many wind parks are shut down for part of the year because of bird migration patterns and turbine-related bird deaths. Furthermore, turbines occupy land; though larger turbines produce more power, they also occupy more land to operate safely. Since man-made installations can have adverse effects on terrestrial ecosystems, environmentalists have lobbied the government to prevent the installation of wind parks.[29]

Government restrictions on foreign wind turbine suppliers in China

State-owned utilities in China have shown a preference for buying wind turbines from low-cost, local manufacturers. There are three leaders in turbine production in China, and 60 smaller companies.[30] Foreign companies like Suzlon have been losing market share in China, which is now the world's largest for wind turbines after several years of nearly 80% annual growth.[30] Chinese manufacturers, which are generally less technologically sophisticated than those of foreign companies, sell turbines for about 5% less than those made by Suzlon, but as much as 20% below those of other foreign companies.[30]

Some Chinese localization rules like those at the largest wind farm in the world in Rudong, China, prevent non-Chinese manufacturers from selling turbines. These rules require 70% of turbine equipment to be sourced and built domestically.[31] The Chinese government has also sought to eliminate turbines with capacities of less than one megawatt, a policy which is favorable to domestic Chinese turbine manufacturers.[31] China's National Energy Administration predicted that China's wind power capacity is likely to rise from 12,000 megawatts at the end of 2008 to 30,000 megawatts by the end of 2011, a goal that will require about 100 billion yuan ($14.6 billion) in investment.[31] However, unfavorable policies for foreign turbine manufacturers in China put companies like Suzlon at a disadvantage and weaken their foothold in one of the most promising wind markets in the world.[31]

Despite China's stringent policies regarding sourcing of wind turbines, it still represents a market with the most growth potential in the world. China relies on coal to generate about 70 percent of electric power.[32] The country is expected to have 120 million to 150 million kilowatts of installed wind power capacity, totaling 7 to 9 percent of the national total installed electricity capacity, in 2020, according to the China Energy and Environment Technology Association.[32] This represents an enormous investment opportunity for wind turbine manufacturers such as Suzlon.

Government Regulation of Energy Markets

Clean energy companies are highly dependent on government subsidies and support to bring in revenue, given that oil, coal, and nuclear energy are cheaper, well-established energy sources and hold oligopolistic control over the world-wide energy market. Given this dependence on the government, many environmental and social movements are focusing on pressuring the government to pave the way for a transition to renewables. Furthermore, many government endorse local renewables as an alternative to foreign fossil fuels, in an attempt to create energy independence. Government support of renewables is taking place at local, national, and global scales. One significant example is that in September 2009, the U.S. government announced it had awarded more than $500 million in grants to help finance wind projects under a $787 billion stimulus package designed to help revive the economy.[18]

The Kyoto Protocol

The Kyoto Protocol is an international agreement to reduce greenhouse gas emissions in a global effort to stop climate change. The Kyoto Protocol mandates emissions caps through cap-and-trade systems of trading carbon credits. This system has the potential to benefit Suzlon as many countries make the transition to renewable energy such as wind power.

The U.S. has not ratified the treaty and has no plans to do so. China, while part of the treaty, is classified as a developing country and therefore has no obligation to lower its emissions.

Domestic Legislation

Given the fear of global warming and pollution, which has led to increasing social support for clean energy sources, governments around the world have implemented legislation that indirectly leads to increased revenues for Suzlon. Examples include:

California has mandated that 25% of electricity come from clean sources by 2020 and 75% by 2050[33]

The Renewable Energy Standard bill, which would require utilities to generate 6% of their energy from renewables by 2012 and 25% by 2025, is being considered at the committee stage in the United States Congress[34]

China's Renewable Energy Law raises the target for the total percentage of renewable energy used in the country to 10% by 2020[36]

In February 2009, President Obama extended tax credits for wind and increased the amount the government will spend on those credits by 30 percent.[37] Obama said he would invest $15 billion a year in renewable energy sources to create five million new energy jobs through 2018.[37]

Legislative mandates like these benefit renewable energy companies because they force utilities companies to turn to other power sources, allowing companies like Suzlon to enter a crowded energy market. Also, such legislation usually leads to government support for renewable energy companies in the form of fiscal incentives.

Competition

Suzlon, which owns a 9.8% global market share,[1] has several major competitors in the wind energy sector.

Vestas (VWSYF) (19%): Vestas Wind Systems A/S is a Denmark-based company that develops, manufactures, markets, and maintains wind power systems that utilize wind energy to generate electricity. It is the largest manufacturer of wind turbines and wind energy systems in the world.

General Electric (18%) is a conglomerate with business units in energy, industrial and consumer technology, media, and finance. GE's wind energy division has installed over 10,000 wind turbines worldwide comprising more than 15,000 MW of capacity.[39]

Gamesa (GCTAF) (11%) is a Spain-based holding company that, through its subsidiaries, develops renewable energy solutions. The company manufactures and sells solar and wind farm components, such as solar panels and wind turbines.

Enercon (9%) is a German-based manufacturer of wind turbines. Enercon has installed about 13,000 of its turbines in more than 30 countries.[40] In addition to its turbine manufacturing business, Enercon manufactures a desalination system that converts sea water into drinking water.

Siemens (7%) is an electronics and electrical engineering conglomerate. Its renewable energy division manufactures wind turbines for both on- and off-shore applications.

While most of these companies are well-established in the global market, Suzlon's ability to produce in low cost countries (China and India) and its focus on high-potential energy markets gives it a powerful competitive advantage. Its growth over the past two years suggests that the business is taking full advantage of expanding markets while improving its efficiency to increase profitability. Suzlon also offers the most turbine models, one for each general wattage category (except for the highest capacities). The chart below illustrates the wide range of generating capacity that Suzlon has in comparison to its major competitors.

It should be noted that the two largest manufacturers, GE and Vestas, produce high capacity turbines. Suzlon produces most capacities, except turbines over 2.5MW, while GE and Vestas produce over 3MW. Low-energy turbines take less area to operate while high-energy turbines produce more power but take up more physical space.

Market Share

Suzlon is the third largest wind turbine manufacturer in the word with 9.8% market share globally.[1] Suzlon has been the market leader in India with more than 4400 MW of installed wind energy projects in 8 states. In FY 2008-09, Suzlon had a market share of more than 50% in the Indian market.[1]